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CONIFER HOLDINGS, INC. – 10-Q – MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For the Periods Ended
The following Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Consolidated Financial Statements (Unaudited), related notes and other financial information appearing elsewhere in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and related notes included in our Annual Report on Form 10-K, filed onMarch 11, 2021 with theU. S. Securities and Exchange Commission .
Forward-Looking Statements
Certain statements contained in this Quarterly Report on Form 10-Q, which are
not statements of historical fact, are forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, as Section 21E
of the Securities Exchange Act of 1934, as amended. Forward-looking statements
give current expectations or forecasts of future events or our future financial
or operating performance. Words such as "anticipate," "believe," "estimate,"
"expect," "intend," "may," "plan," "seek" and similar terms and phrases, or the
negative thereof, may be used to identify forward-looking statements.
The forward-looking statements contained in this report are based on
management's good-faith belief and reasonable judgment based on current
information. The forward-looking statements are qualified by important factors,
risks and uncertainties, many of which are beyond our control, that could cause
our actual results to differ materially from those in the forward-looking
statements, including those described in our Form 10-K ("Item 1A Risk Factors")
filed with the SEC on March 11, 2021 and subsequent reports filed with or
furnished to the SEC . Any forward-looking statement made by us in this report
speaks only as of the date hereof or as of the date specified herein. We
undertake no obligation to publicly update any forward-looking statement,
whether as a result of new information, future developments or otherwise, except
as may be required by any applicable laws or regulations.
Recent Developments
COVID-19
COVID-19 (the "Pandemic") continues to cause significant disruption to public health, the global economy, financial markets, and commercial, social and community activity in general. As there has been a significant reduction in reported cases and correspondingly a reduction in government restrictions, we see reduced risk to our business. We continue to monitor potential risks the Pandemic may present including a potential resurgence. Our exposure to the Pandemic is manifold. The majority of our employees continue to work remotely however strict "shelter-in-place" or "stay-at-home" orders have been lifted. A significant portion of our revenues are generated from the hospitality sector within theU.S. which remains under stress due to the threats of resurgence and resource shortages that resulted from the Pandemic. We have continued to provide customer service, process new and renewal business, handle claims and otherwise manage all operations even though the vast majority of the staff is working remotely. To date, we have not seen a major disruption in our business as a result of the Pandemic and currently do not expect to see a material negative impact to our financial position or results of operations as a result of the Pandemic.
Sale of Certain Agency Business
OnJune 30, 2021 , our agency (Sycamore Insurance Agency ) sold toVenture Agency Holdings, Inc. the customer accounts and other related assets of some of its personal and commercial lines of business (the "Venture Transaction"). Sycamore will continue to produce various personal and commercial lines that it did not sell which is substantially all produced for, and underwritten by, our Insurance Company Subsidiaries. We recognized an$8.9 million gain on the sale which is reflected in Other Gains on the Consolidated Statement of Operations. The purchase price was$10.0 million of which$1.0 million was paid in cash onJune 30, 2021 , and$9.0 million was in the form of two promissory notes (one for$6.0 million and one for$3.0 million ). Both notes require interest-only quarterly payments at a per annum rate of 7.0%, with a five-year maturity. The assets sold included the customer accounts (mainly agency-related new and renewal rights) of substantially all of the personal lines business and a small subset of the commercial lines business underwritten by ourInsurance Company Subsidiaries, and all of the customer accounts Sycamore produced for third-party insurers. The Venture Transaction included the transition of 21 employees from CHI to Venture as well as necessary systems and office functions to operate the business. 23
-------------------------------------------------------------------------------- Venture did not assume any in-force business or liabilities. The business will roll over to Venture as it produces new or renewal business effectiveJuly 1, 2021 . We expect our Insurance Company Subsidiaries will continue to underwrite substantially all of the business we sold to Venture that we underwrote prior to the transaction. We expect Venture to be able to grow both the business we underwrite plus the third-party business more effectively as a separate entity outside of CHI's group. As ofJune 30, 2021 andSeptember 30, 2021 , we had a non-controlling 50% interest in Venture.
Business Overview
We are an insurance holding company that markets and services our product offerings through specialty commercial and specialty personal insurance business lines. Our growth has been significant since our founding in 2009. Currently, we are authorized to write insurance as an excess and surplus lines carrier in 45 states, including theDistrict of Columbia . We are also licensed to write insurance as an admitted carrier in 42 states, including theDistrict of Columbia , and we offer our insurance products in all 50 states.
Our revenues are primarily derived from premiums earned from our insurance
operations. We also generate other revenues through investment income and other
income which mainly consists of installment fees and policy issuance fees
generally related to the policies we write.
Our expenses consist primarily of losses and loss adjustment expenses, agents' commissions, and other underwriting and administrative expenses. We organize our operations into three insurance businesses: commercial insurance lines, personal insurance lines, and wholesale agency business. Together, the commercial and personal lines refer to "underwriting" operations that take insurance risk, and the wholesale agency business refers to non-risk insurance business. Through our commercial insurance product lines, we offer coverage for both commercial property and commercial liability. We also offer coverage for commercial automobiles and workers' compensation. Our insurance policies are sold to targeted small and mid-sized businesses on a single or multiple-coverage basis. Through our personal insurance product lines, we offer homeowners insurance and dwelling fire insurance policies to individuals in several states. Our specialty homeowners insurance product line is primarily comprised of low-value dwelling insurance tailored for owners of lower valued homes, which we offer inIllinois ,Indiana andTexas . Due to recentFlorida -based industry events, we have been de-emphasizing ourFlorida homeowners' business and reducing our exposures in that state, as well as other wind-exposed states likeTexas andHawaii . Through our wholesale agency business segment, we offer commercial and personal lines insurance products for our Insurance Company Subsidiaries as well as third-party insurers. We have expanded the wholesale agency business to develop more non-risk revenue streams, and provide our agents with more insurance product options. However, as a result of the sale of certain agency business onSeptember 30, 2021 , going forward, our agency segment will not be producing any significant amounts of business for third-party insurers and will produce approximately 50% less business for the Insurance Company Subsidiaries.
Critical Accounting Policies and Estimates
In certain circumstances, we are required to make estimates and assumptions that affect amounts reported in our consolidated financial statements and related footnotes. We evaluate these estimates and assumptions periodically on an on-going basis based on a variety of factors. There can be no assurance, however, that actual results will not be materially different than our estimates and assumptions, and that reported results of operations will not be affected by accounting adjustments needed to reflect changes in these estimates and assumptions. During the nine months endedSeptember 30, 2021 , there were no material changes to our critical accounting policies and estimating methodologies, which are disclosed in "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in the Company's Annual Report on Form 10-K filed with theSEC onMarch 11, 2021 .
Executive Overview
The Company reported$33.7 million of gross written premiums in the third quarter of 2021, representing a 12.9% increase as compared to the same period in 2020. Gross written premiums were$99.1 million for the nine months endedSeptember 30, 2021 , representing a 20.1% increase as compared to the same period in 2020. The increase in both periods was the result of growth in both commercial and personal lines business as we continue to penetrate markets where we have been the most successful while still reducing exposure to less profitable lines. The Company reported a net loss of$1.2 million , or$0.12 per share, and a net loss of$293,000 , or$0.03 per share, for the three and nine months endedSeptember 30, 2021 , respectively. The Company reported net income of$541,000 , or$0.06 per share, and a net loss of$2.7 million , or$0.28 per share, for three and nine months endedSeptember 30, 2020 , respectively. 24 -------------------------------------------------------------------------------- Adjusted operating loss, a non-GAAP measure, was$1.7 million , or$0.18 per share for the three months endedSeptember 30, 2021 . Adjusted operating loss was$12.6 million , or$1.30 per share for the nine months endedSeptember 30, 2021 . Adjusted operating loss was$2.4 million , or$0.24 per share for the three months endedSeptember 30, 2020 . Adjusted operating loss was$5.6 million , or$0.58 per share for the nine months endedSeptember 30, 2020 . Our underwriting combined ratio was 106.9% and 116.0% for the three and nine months endedSeptember 30, 2021 , compared to 110.7% and 107.7% for the three and nine months endedSeptember 30, 2020 , respectively.
Results of Operations For The Three Months Ended
The following table summarizes our operating results for the periods indicated
(dollars in thousands):
Summary of Operating Results
Three Months Ended
September 30,
2021 2020 $ Change % Change
Gross written premiums $ 33,704 $ 29,841 $ 3,863 12.9 %
Net written premiums $ 26,069 $ 25,043 $ 1,026 4.1 %
Net earned premiums $ 24,941 $ 22,227 $ 2,714 12.2 %
Other income 752 642 110 17.1 %
Losses and loss adjustment expenses, net 16,159 14,553
1,606 11.0 % Policy acquisition costs 7,173 6,483 690 10.6 % Operating expenses 4,077 4,537 (460 ) (10.1 )% Underwriting gain (loss) (1,716 ) (2,704 ) 988 * Net investment income 514 776 (262 ) (33.8 )% Net realized investment gains (101 ) 3,316 (3,417 ) * Change in fair value of equity securities (2,169 ) (356 ) (1,813 ) * Other gains 2,778 - 2,778 * Interest expense 701 723 (22 ) (3.0 )% Income (loss) before equity earnings in Affiliate and income taxes (1,395 ) 309 (1,704 ) * Equity earnings in Affiliate, net of tax 184 188 (4 ) * Income tax expense (2 ) (44 ) 42 * Net income (loss)$ (1,209 ) $ 541 $ (1,750 ) *
Book value per common share outstanding
Underwriting Ratios: Loss ratio (1) 64.6 % 65.2 % Expense ratio (2) 42.3 % 45.5 % Combined ratio (3) 106.9 % 110.7 %
(1) The loss ratio is the ratio, expressed as a percentage, of net losses and
loss adjustment expenses to net earned premiums and other income from
underwriting operations.
(2) The expense ratio is the ratio, expressed as a percentage, of policy
acquisition costs and other underwriting expenses to net earned premiums and
other income from underwriting operations.
(3) The combined ratio is the sum of the loss ratio and the expense ratio. A
combined ratio under 100% indicates an underwriting profit. A combined ratio
over 100% indicates an underwriting loss.
* Percentage change is not meaningful.
Premiums
Premiums are earned ratably over the term of the policy, whereas written
premiums are reflected on the effective date of the policy. Almost all
commercial lines and homeowners products have annual policies, under which
premiums are earned
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evenly over one year. The resulting net earned premiums are impacted by the
gross and ceded written premiums, earned ratably over the terms of the policies.
Our premiums are presented below for the three months ended
and 2020 (dollars in thousands):
Summary of Premium Revenue
Three Months Ended
September 30,
2021 2020 $ Change % Change
Gross written premiums
Commercial lines $ 29,849 $ 27,297 $ 2,552 9.3 %
Personal lines 3,855 2,544 1,311 51.5 %
Total $ 33,704 $ 29,841 $ 3,863 12.9 %
Net written premiums
Commercial lines $ 22,456 $ 22,763 $ (307 ) (1.3 )%
Personal lines 3,613 2,280 1,333 58.5 %
Total $ 26,069 $ 25,043 $ 1,026 4.1 %
Net earned premiums
Commercial lines $ 21,975 $ 20,586 $ 1,389 6.7 %
Personal lines 2,966 1,641 1,325 80.7 %
Total $ 24,941 $ 22,227 $ 2,714 12.2 %
Gross written premiums increased $3.9 million , or 12.9%, to $33.7 million for
the three months ended September 30, 2021 , as compared to $29.8 million for the
same period in 2020.
Commercial lines gross written premiums increased $2.6 million , or 9.3%, to
$29.8 million in the third quarter of 2021, as compared to $27.3 million for the
third quarter of 2020. The increase was due to $4.8 million of premium growth in
the small business programs, partially offset by a $2.3 million reduction of
gross written premium in the Company's hospitality programs.
Personal lines gross written premiums increased $1.3 million , or 51.5%, to $3.9
million in the third quarter of 2021, as compared to $2.5 million for the same
period in 2020. The increased gross written premiums were due to continued
growth in the Company's low-value dwelling book of business.
Net written premiums increased $1.0 million , or 4.1%, to $26.1 million for the
three months ended September 30, 2021 , as compared to $25.0 million for the same
period in 2020. Net written premiums did not increase as much as gross written
premiums due to a combination of factors that increased our ceded premium
rates. Our blended ratio of ceded earned premiums to gross earned premiums
increased from 17.3% to 21.5% in the third quarters of 2020 and 2021,
respectively. The increase was due to a combination of: 1) a change in the mix
of business to more property exposure which has a higher ceding rate; 2) general
reinsurance rate increases; 3) we purchased more reinsurance as of January 1,
2021 to reduce our commercial property specific loss retention to $200,000 , from
$340,000 , and 4) we are writing more business in select areas that are mostly
ceded under quota share agreements that skew the blended ceded earned premium to
gross earned premium ratio.
Other Income
Other income consists primarily of fees charged to policyholders by the Company
for services outside of the premium charge, such as installment billings and
policy issuance costs. Other income also includes the interest income from the
$9.0 million of the notes payable from Venture relating to the Venture
Transaction. Commission income is also received by the Company's insurance
agency for writing policies for third-party insurance companies. All of the
third-party business was sold to Venture at June 30, 2021 . Accordingly, other
income from that business will diminish over the next few quarters as it
transitions over to Venture, and will ultimately no longer occur. Other income
for the three months ended September 30, 2021 , increased by $110,000 , or 17.1%,
to $752,000 as compared to $642,000 for the same period in 2020. Other income
relating to installment billings and policy issuance costs was lower in 2021,
particularly in the third quarter, as the business that was sold to Venture at
June 30, 2021 , no longer produces other income for the Company. This was more
than offset by an increase in the interest income from the notes payable of
$158,000 in the third quarter of 2021.
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Other Gains
Other gains were$2.8 million for the three months endedSeptember 30, 2021 , compared to$0 for the same period in 2020. The Company received notice from the SBA that the PPP loan was 100% forgiven, including accrued interest, onJuly 8, 2021 . This resulted in a$2.8 million gain that is included in Other Gains on the Consolidated Statement of Operations in the third quarter of 2021.
Losses and Loss Adjustment Expenses
The tables below details our losses and loss adjustment expenses and loss ratios in our underwriting business for the three months endedSeptember 30, 2021 and 2020 (dollars in thousands). Commercial Personal Three months ended September 30, 2021 Lines Lines
Total
Accident year net losses and LAE
Net (favorable) adverse development
3,356 290
3,646
Calendar year net losses and LAE
Accident year loss ratio 51.5 % 39.1 % 50.0 %
Net (favorable) adverse development 15.2 % 9.7 % 14.6 %
Calendar year loss ratio 66.7 % 48.8 % 64.6 %
Commercial Personal
Three months ended September 30, 2020 Lines Lines
Total
Accident year net losses and LAE
Net (favorable) adverse development
4,630 64
4,694
Calendar year net losses and LAE
Accident year loss ratio 46.4 % 17.5 % 44.2 % Net (favorable) adverse development 22.4 % 3.8 % 21.0 % Calendar year loss ratio 68.8 % 21.3 % 65.2 % Net losses and LAE increased by$1.6 million , or 11.0%, to$16.2 million during the third quarter of 2021, compared to$14.6 million for the same period in 2020. The increase in losses was driven by current accident year losses increasing$3.6 million to$12.5 million for the three months endedSeptember 30, 2021 , compared to$8.9 million for the same period in 2020. The Company experienced$3.6 million of adverse development for the three months endedSeptember 30, 2021 , of which$1.1 million was related to 2017 and prior accident years,$1.4 million was related to the 2018 accident year, and$1.0 million was related to the 2019 accident year. In the third quarter of 2021,$3.4 million of the adverse development was related to the commercial lines of business, mostly from the liability lines, while$290,000 was related to the personal lines of business.
The Company's incurred losses during the three months ended
included adverse prior-year reserve
development of
unfavorable reserve development of which
$2.9 million was incurred in our hospitality programs, and$1.7 million was from our small business programs (mostly in the liability coverages). The adverse development was attributable to the 2018 and prior accident years.
Expense Ratio
Our expense ratio is a measure of the efficiency and performance of the
commercial and personal lines of business (our risk-bearing underwriting
operations). It is calculated by dividing the sum of policy acquisition costs
and other underwriting expenses by the sum of net earned premiums and other
income of the underwriting business. Costs that cannot be readily identifiable
as a direct cost of a segment or product line remain in Corporate for segment
reporting purposes. The expense ratio excludes wholesale agency and Corporate
expenses.
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The table below provides the expense ratio by major component.
Three Months Ended
September 30,
2021 2020
Commercial Lines
Policy acquisition costs 29.3 % 30.0 %
Operating expenses 13.4 % 15.4 %
Total 42.7 % 45.4 %
Personal Lines
Policy acquisition costs 28.0 % 31.9 %
Operating expenses 11.2 % 14.9 %
Total 39.2 % 46.8 %
Total Underwriting
Policy acquisition costs 29.2 % 30.1 %
Operating expenses 13.1 % 15.4 %
Total 42.3 % 45.5 %
Our expense ratio decreased by 3.2 percentage points in the third quarter of
2021 as compared to the same period in 2020. The decrease was largely due to
underwriting revenue, which consists of net earned premiums and other
underwriting income, increasing by $2.8 million , or 12.3% to $25.7 million for
the three months ended September 30, 2021 , compared to $22.9 million during the
same period in 2020.
Policy acquisition costs are costs we incur to issue policies, which include
commissions, premium taxes, underwriting reports and underwriter compensation
costs. The Company offsets direct commissions with ceded commissions from
reinsurers. For the three months ended September 30, 2021 and 2020, the
percentage of policy acquisition costs to net earned premiums and other
underwriting income decreased by 0.9 percentage points to 29.2% compared to
30.1%, respectively. Acquisition costs are lower due to a combination of a
change in mix of business with lower average acquisition costs, less expensive
fronting arrangements, and more ceding commissions in select areas that are
mostly ceded under quota share agreements.
Operating expenses consist primarily of employee compensation, information
technology and occupancy costs, such as rent and utilities. Operating expenses
as a percent of net earned premiums and other underwriting income were 13.1% and
15.4% for the three months ended September 30, 2021 and 2020, respectively. The
operating expense ratio was lower due to our expense reduction efforts, where
there has been a real nominal dollar decrease in operating expenses, coupled
with net earned premium growth.
Segment Results
We measure the performance of our consolidated results, in part, based on our underwriting gain or loss. The following table provides the underwriting gain or loss for the three months endedSeptember 30, 2021 and 2020 (dollars in thousands): Segment Gain (Loss) Three Months Ended September 30, 2021 2020 $ Change Commercial Lines$ (2,084 ) $ (2,932 ) $ 848 Personal Lines 359 537 (178 ) Total Underwriting (1,725 ) (2,395 ) 670 Wholesale Agency (43 ) (71 ) 28 Corporate (139 ) (277 ) 138 Eliminations 191 39 152 Total segment gain (loss)$ (1,716 ) $ (2,704 ) $ 988 28
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Results of Operations For The Nine Months Ended
The following table summarizes our operating results for the periods indicated
(dollars in thousands):
Nine months ended
September 30,
2021 2020 $ Change % Change
Gross written premiums $ 99,058 $ 82,470 $ 16,588 20.1 %
Net written premiums $ 79,084 $ 69,159 $ 9,925 14.4 %
Net earned premiums $ 72,614 $ 66,002 $ 6,612 10.0 %
Other income 1,974 2,013 (39 ) (1.9 )%
Losses and loss adjustment expenses, net 53,447 40,767 12,680 31.1 %
Policy acquisition costs 20,819 19,181 1,638 8.5 %
Operating expenses 12,768 14,441 (1,673 ) (11.6 )%
Underwriting gain (loss) (12,446 ) (6,374 ) (6,072 ) (95.3 )%
Net investment income 1,549 2,593 (1,044 ) (40.3 )%
Net realized investment gains 3,883 4,489 (606 ) (13.5 )%
Change in fair value of equity
securities (3,234 ) (1,866 ) (1,368 ) *
Other gains 11,688 260 11,428 *
Interest expense 2,154 2,185 (31 ) (1.4 )%
Income (loss) before equity earnings in
Affiliate and income taxes (714 ) (3,083 ) 2,369 *
Equity earnings in Affiliate, net of tax 612 417 195 *
Income tax expense 191 13 178 *
Net income (loss) $ (293 ) $ (2,679 ) $ 2,386 *
Book value per common share outstanding
Underwriting Ratios: Loss ratio (1) 73.3 % 61.5 % Expense ratio (2) 42.7 % 46.2 % Combined ratio (3) 116.0 % 107.7 %
(1) The loss ratio is the ratio, expressed as a percentage, of net losses and
loss adjustment expenses to net earned premiums and other income from
underwriting operations.
(2) The expense ratio is the ratio, expressed as a percentage, of policy
acquisition costs and other underwriting expenses to net earned premiums and
other income from underwriting operations.
(3) The combined ratio is the sum of the loss ratio and the expense ratio. A
combined ratio under 100% indicates an underwriting profit. A combined ratio
over 100% indicates an underwriting loss.
* Percentage change is not meaningful.
Premiums
Premiums are earned ratably over the term of the policy, whereas written
premiums are reflected on the effective date of the policy. Almost all
commercial lines and homeowners products have annual policies, under which
premiums are earned evenly over one year. The resulting net earned premiums are
impacted by the gross and ceded written premiums, earned ratably over the terms
of the policies.
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Our premiums are presented below for the nine months ended
and 2020 (dollars in thousands):
Nine months ended
September 30,
2021 2020 $ Change % Change
Gross written premiums
Commercial lines $ 88,017 $ 76,341 $ 11,676 15.3 %
Personal lines 11,041 6,129 4,912 80.1 %
Total $ 99,058 $ 82,470 $ 16,588 20.1 %
Net written premiums
Commercial lines $ 68,685 $ 63,827 $ 4,858 7.6 %
Personal lines 10,399 5,332 5,067 95.0 %
Total $ 79,084 $ 69,159 $ 9,925 14.4 %
Net earned premiums
Commercial lines $ 64,869 $ 61,122 $ 3,747 6.1 %
Personal lines 7,745 4,880 2,865 58.7 %
Total $ 72,614 $ 66,002 $ 6,612 10.0 %
Gross written premiums increased $16.6 million , or 20.1%, to $99.1 million for
the nine months ended September 30, 2021 , as compared to $82.5 million for the
same period in 2020.
Commercial lines gross written premiums increased $11.7 million , or 15.3%, to
$88.0 million for the nine months ended September 30, 2021 , as compared to $76.3
million for the same period in 2020. There was a $17.0 million increase in the
small business programs, which was partially offset by a $5.4 million reduction
of gross written premium in the Company's hospitality programs. Of the $5.4
million decrease in gross written premium in the hospitality programs, $5.1
million was from our quick service restaurant line, which has seen some of the
larger losses within the hospitality lines of business.
Personal lines gross written premiums increased $4.9 million , or 80.1%, to $11.0
million for the nine months ended September 30, 2021 , as compared to $6.1
million for the same period in 2020. The increase was due to continued growth in
the Company's low-value dwelling book of business.
Net written premiums increased $9.9 million , or 14.4%, to $79.1 million for the
nine months ended September 30, 2021 , as compared to $69.2 million for the same
period in 2020. Net written premiums did not increase as much as gross written
premiums due to a combination of factors that increased our ceded premium
rates.
Our blended ratio of ceded earned premiums to gross earned premiums increased
from 16.3% to 19.5% in nine months ended September 30, 2020 and 2021,
respectively. The increase in the ceded earned premium-to-gross earned premium
ratio was due, in part, to a $2.3 million increase in gross earned premiums
relating to a growing commercial umbrella liability program that is almost
entirely ceded under a quota share agreement. This increased the ratio by 2.4
percentage points. However, we also received a ceding commission from this
business that has reduced our acquisition costs. The remainder of the increase
was due to a combination of: 1) a change in the mix of business to more property
exposure which has a higher ceding rate; 2) general reinsurance rate increases;
and 3) we purchased more reinsurance as of January 1, 2021 to reduce our
commercial property specific loss retention to only $200,000 , from $340,000 .
Other Income
Other income consists primarily of fees charged to policyholders by the Company
for services outside of the premium charge, such as installment billings and
policy issuance costs. Other income also includes the interest income from the
$9.0 million of notes payable from Venture relating to the Venture
Transaction. Commission income is also received by the Company's insurance
agency for writing policies for third-party insurance companies. All of the
third-party business was sold to Venture at June 30, 2021 . Accordingly, other
income from that business will diminish over the next few quarters as it
transitions over to Venture, and will ultimately no longer occur. Other income
remained flat at $2.0 million for both the nine months ended September 30, 2021
and 2020. Other income relating to installment billings and policy issuance
costs was lower in 2021, particularly in the third quarter, as the business that
was sold to Venture at June 30, 2021 , no longer produces other income for the
Company. This was partially offset by an increase in the interest income from
the notes payable of $158,000 in the third quarter of 2021.
30
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Other Gains
Other gains were$11.7 million for the nine months endedSeptember 30, 2021 , compared to$260,000 for the same period in 2020. The Company sold a portion of its Agency business during the second quarter of 2021, resulting in an$8.9 million gain. Additionally, the Company received notice from the SBA that the PPP loan was 100% forgiven, including accrued interest, onJuly 8, 2021 . This resulted in a$2.8 million gain that is included in Other Gains on the Consolidated Statement of Operations in the third quarter of 2021. The$260,000 gain for the nine months endedSeptember 30, 2020 was due to the repurchase of 36,761 units of the Notes at a discount to face value.
Losses and Loss Adjustment Expenses
The tables below detail our losses and loss adjustment expenses and loss ratios in our underwriting business for the nine months endedSeptember 30, 2021 and 2020 (dollars in thousands). Commercial Personal Nine months ended September 30, 2021 Lines Lines
Total
Accident year net losses and LAE
Net (favorable) adverse development 14,708
926
15,634
Calendar year net losses and LAE
Accident year loss ratio 52.1 % 50.0 % 51.9 %
Net (favorable) adverse development 22.6 % 11.8 % 21.4 %
Calendar year loss ratio 74.7 % 61.8 % 73.3 %
Commercial Personal
Nine months ended September 30, 2020 Lines Lines
Total
Accident year net losses and LAE
Net (favorable) adverse development 11,371
109
11,480
Calendar year net losses and LAE
Accident year loss ratio 45.0 % 34.5 % 44.2 % Net (favorable) adverse development 18.5 % 2.2 % 17.3 % Calendar year loss ratio 63.5 % 36.7 % 61.5 % Net losses and LAE increased by$12.7 million , or 31.1%, to$53.4 million for the nine months endedSeptember 30, 2021 , compared to$40.8 million for the same period in 2020. The Company experienced$2.0 million of catastrophe losses, net of reinsurance recoverables, during the first quarter of 2021 from Winter Storm Uri. The Company also experienced$15.6 million of adverse development for the nine months endedSeptember 30, 2021 , which increased losses further. Of the$15.6 million in adverse development,$14.7 million was related to commercial lines, while$926,000 was related to personal lines. The adverse development was mostly attributable to the 2019, 2018 and 2017 and prior accident years, and mostly related to commercial liability lines. The Company's incurred losses during the nine months endedSeptember 30, 2020 , included adverse prior-year reserve development of$11.5 million . The Commercial lines experienced$11.4 million of unfavorable reserve development for the nine months endedSeptember 30, 2020 , of which$8.5 million was incurred in our hospitality programs, while$2.9 million was from our small business programs (mostly in the liability coverages). The adverse development was mostly attributable to the 2018 and prior accident years.
Expense Ratio
Our expense ratio is a measure of the efficiency and performance of the
commercial and personal lines of business (our risk-bearing underwriting
operations). It is calculated by dividing the sum of policy acquisition costs
and other underwriting expenses by the sum of net earned premiums and other
income of the underwriting business. Costs that cannot be readily identifiable
as a direct cost of a segment or product line remain in Corporate for segment
reporting purposes. The expense ratio excludes wholesale agency and Corporate
expenses.
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The table below provides the expense ratio by major component.
Nine months ended
September 30,
2021 2020
Commercial Lines
Policy acquisition costs 29.4 % 30.1 %
Operating expenses 13.5 % 16.0 %
Total 42.9 % 46.1 %
Personal Lines
Policy acquisition costs 27.7 % 30.7 %
Operating expenses 13.7 % 16.0 %
Total 41.4 % 46.7 %
Total Underwriting
Policy acquisition costs 29.2 % 30.2 %
Operating expenses 13.5 % 16.0 %
Total 42.7 % 46.2 %
Our expense ratio decreased by 3.5 percentage points for the nine months ended
Policy acquisition costs are costs we incur to issue policies, which include commissions, premium taxes, underwriting reports and underwriter compensation costs. The Company offsets direct commissions with ceded commissions from reinsurers. For the nine months endedSeptember 30, 2021 and 2020, the percentage of policy acquisition costs to net earned premiums and other underwriting income decreased by 1.0 percentage point to 29.2% compared to 30.2%, respectively. Acquisition costs are lower due to a combination of a change in mix of business with lower average acquisition costs, less expensive fronting arrangements, and more ceding commissions in select areas that are mostly ceded under quota share agreements. Operating expenses consist primarily of employee compensation, information technology and occupancy costs, such as rent and utilities. Total underwriting operating expenses as a percent of net earned premiums and other underwriting income were 13.5% and 16.0% for the nine months endedSeptember 30, 2021 and 2020, respectively. The operating expense ratio was lower due to our expense reduction efforts, where there has been a real nominal dollar decrease in operating expenses, coupled with net earned premium growth.
Segment Results
We measure the performance of our consolidated results, in part, based on our underwriting gain or loss. The following table provides the underwriting gain or loss for the nine months endedSeptember 30, 2021 and 2020 (dollars in thousands): Segment Gain (Loss) Nine months ended September 30, 2021 2020 $ Change Commercial Lines$ (11,428 ) $ (5,907 ) $ (5,521 ) Personal Lines (251 ) 828 (1,079 ) Total Underwriting (11,679 ) (5,079 ) (6,600 ) Wholesale Agency (275 ) (353 ) 78 Corporate (652 ) (1,182 ) 530 Eliminations 160 240 (80 ) Total segment gain (loss)$ (12,446 ) $ (6,374 ) $ (6,072 ) 32
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Liquidity and Capital Resources
Sources and Uses of Funds
AtSeptember 30, 2021 , we had$17.6 million in cash, cash equivalents and short-term investments. Our principal sources of funds are insurance premiums, investment income, proceeds from maturities and sales of invested assets and installment fees. These funds are primarily used to pay claims, commissions, employee compensation, taxes and other operating expenses, and service debt. We believe that our existing cash, cash equivalents, short-term investments and investment securities balances will be adequate to meet our capital and liquidity needs and the needs of our subsidiaries on a short-term and long-term basis. We conduct our business operations primarily through ourInsurance Company Subsidiaries. Our ability to service debt, and pay administrative expenses is primarily reliant upon our intercompany service fees paid by the Insurance Company Subsidiaries to the Parent Company for management, administrative, and information technology services provided to the Insurance Company Subsidiaries by the Parent Company. Secondarily, the Parent Company may receive dividends from the Insurance Company Subsidiaries; however, this is not the primary means in which the Parent Company supports its funding as state insurance laws restrict the ability of our Insurance Company Subsidiaries to declare dividends to the Parent Company. There were no dividends paid from ourInsurance Company Subsidiaries during the nine months endedSeptember 30, 2021 and 2020.
Cash Flows
Operating Activities. Cash used in operating activities for the nine months endedSeptember 30, 2021 , was$2.0 million , compared to$3.0 million used for the same period in 2020. There was$12.2 million more premiums collected, net of reinsurance costs, in 2021, compared to 2020, as we continue to increase gross written premiums. This was offset by$7.2 million more claim payments made in 2021, net of reinsurance recovered (in part due to Winter Storm Uri),$3.0 million more acquisition costs paid in 2021, compared to 2020, as gross written premiums increased, and$1.1 million decrease in investment income received. Investing Activities. Cash provided by investing activities for the nine months endedSeptember 30, 2021 , was$5.3 million , as compared to$2.0 million of cash used in investing activities for the same period in 2020. The$7.3 million increase in cash provided by investing activities was driven by a reduction in the purchases of investments in the first nine months of 2021, compared to the same period in 2020. There was a significant repositioning of the Company's portfolio during the nine months of 2020 from the COVID-19 pandemic, which caused an increase in the purchases of investments. Financing Activities. Cash used in financing activities for the nine months endedSeptember 30, 2021 , was$4.0 million , compared to$5.1 million of cash provided by financing activities for the same period in 2020. The$9.1 million decrease in cash provided by financing activities was mostly due to the Company paying down a net amount of$4.0 million of its outstanding balance on its line of credit during the first nine months of 2021.
Our Insurance Company Subsidiaries are required to file quarterly and annual financial reports with state insurance regulators. These financial reports are prepared using statutory accounting practices promulgated by the Insurance Company Subsidiaries' state of domiciliary, rather than GAAP. The Insurance Company Subsidiaries' aggregate statutory capital and surplus (which is a statutory measure of equity) was$57.8 million and$64.1 million atSeptember 30, 2021 andDecember 31, 2020 , respectively. 33
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Non-GAAP Financial Measures
Adjusted Operating Income and Adjusted Operating Income Per Share
Adjusted operating income and adjusted operating income per share are non-GAAP
measures that represent net income allocable to common shareholders excluding
net realized investment gains or losses, changes in fair value of equity
securities, and other gains or losses; all net of tax. The most directly
comparable financial GAAP measures to adjusted operating income and adjusted
operating income per share are net income and net income per share,
respectively. Adjusted operating income and adjusted operating income per share
are intended as supplemental information and are not meant to replace net income
or net income per share. Adjusted operating income and adjusted operating income
per share should be read in conjunction with the GAAP financial results. Our
definition of adjusted operating income may be different from that used by other
companies. The following is a reconciliation of net income (loss) to adjusted
operating income (loss) (dollars in thousands), as well as net income (loss) per
share to adjusted operating income (loss) per share:
Three Months Ended Nine months ended
September 30, September 30,
2021 2020 2021 2020
Net income (loss) $ (1,209 ) $ 541 $ (293 ) $ (2,679 )
Exclude:
Net realized investment gains and other
gains, net of tax 2,677 3,316 15,571 4,749
Change in fair value of equity
securities, net of tax (2,169 ) (356 ) (3,234 ) (1,866 )
Adjusted operating income (loss) $ (1,717 ) $ (2,419 )
Weighted average common shares diluted 9,692,150 9,630,600
9,686,874 9,606,436 Diluted income (loss) per common share: Net income (loss)$ (0.12 ) $ 0.06 $ (0.03 ) $ (0.28 ) Exclude: Net realized investment gains and other gains, net of tax 0.28 0.34 1.61 0.49 Change in fair value of equity securities, net of tax (0.22 ) (0.04 ) (0.33 ) (0.19 ) Adjusted operating income (loss) per share$ (0.18 ) $ (0.24 ) $ (1.30 ) $ (0.58 ) We use adjusted operating income and adjusted operating income per share to assess our performance and to evaluate the results of our overall business. We believe these measures provide investors with valuable information relating to our ongoing performance that may be obscured by the net effect of realized gains and losses as a result of our market risk sensitive instruments, which primarily relate to debt securities that are available for sale and not held for trading purposes. The change in fair value of equity securities and realized gains and losses may vary significantly between periods and are generally driven by external economic developments, such as capital market conditions. Accordingly, adjusted operating income excludes the effect of items that tend to be highly variable from period to period and highlights the results from our ongoing business operations and the underlying results of our business. We believe that it is useful for investors to evaluate adjusted operating income and adjusted operating income per share, along with net income and net income per share, when reviewing and evaluating our performance.
Recently Issued Accounting Pronouncements
Refer to Note 1 ~ Summary of Significant Accounting Policies - Recently Issued
Accounting Guidance of the Notes to the Consolidated Financial Statements for
detailed information regarding recently issued accounting pronouncements.
34
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